Treasury Five-Year Note Yield Falls to Record on Fed Rate Pledge

Treasuries rallied, pushing the five-year note yield to a record low, after Federal Reserve officials unexpectedly said their benchmark interest rate will stay low until at least late 2014.

U.S. government debt pared gains after the release of forecasts by Federal Open Market Committee participants for the first time showed three of the 17 members said the Fed should raise rates in 2012 and three said tighten in 2013. The Treasury sold $35 billion of five-year notes at higher-than-average demand prior to the disclosure of the forecasts.

“This was a very dovish statement,” said Gary Pollack, head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York, which manages $12 billion in bonds. “They are pushing out rate hikes till at least the end of 2014, longer than what the market was preparing for. It shows that they don’t think the strength in the economy is strong enough where it will cause an increase in inflationary pressures, so that’s positive for fixed-income investors.”

Yields on 10-year notes fell seven basis points, or 0.07 percentage point, to 1.99 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The yield on the current five-year note fell 10 basis points to 0.79 percent after touching the record low of 0.76 percent.

Treasury yields dropped as the Fed extended the horizon on its pledge made Aug. 9 to keep its benchmark interest rate at a record low level at least through mid-2013. The FOMC has left its target for overnight loans between banks in a range of zero to 0.25 percent since December 2008.

Break-Even Rate

Policy makers said growth in U.S. gross domestic product centered around 2.2 percent to 2.7 percent, down from 2.5 percent to 2.9 percent in November. Most expect inflation on the personal consumption expenditures index between 1.4 percent to 1.8 percent, down from 1.4 percent to 2 percent in November.

The difference between rates on five-year notes and Treasury Inflation Protected Securities, a reflection of traders’ outlook known as the break-even rate, rose to 1.78 percentage points, the highest since Nov. 15.

“A more dovish and stimulative Fed means that they are risking inflation in order to get the unemployment rate down, which is causing break-evens to rally,” said Michael Pond, co-head of interest-rate strategy in New York at Barclays Plc, one of 21 primary dealers that trade with the Fed.

Bernanke, speaking at a news conference after the statements, said that the option of further large-scale bond purchases is still “on the table.”

‘Case’ for Stimulus

“If inflation is going to remain below target for an extended period and employment progress” is very slow, then “there is a case” for additional monetary stimulus, he said.

The Fed said it would continue to extend the average maturity of its $2.6 trillion securities portfolio, a move dubbed by traders Operation Twist. The Fed also maintained its policy of reinvesting maturing housing debt into agency mortgage-backed securities.

U.S. debt rose earlier after the Treasury’s five-year notes auction drew a yield of 0.899 percent, compared with a forecast of 0.919 percent in a Bloomberg News survey of 10 primary dealers. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.17, the highest since May, versus an average of 2.863 for the previous 10 sales.

“We’ve cheapened up in recent days, making the sector more attractive,” said Justin Lederer, an interest-rate strategist in New York at Cantor Fitzgerald LP, a primary dealer. “Investors are still hunting for yield.”

Indirect bidders, an investor class that includes foreign central banks, purchased 43.4 percent of the notes, compared with an average of 43.7 percent for the past 10 sales.

Second of Three

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 15.1. percent of the notes, compared with an average of 11.3 percent at the last 10 auctions.

Today’s auction was the second of three note sales totaling $99 billion this week. The U.S. sold $35 billion of two-year notes yesterday and will auction $29 billion of seven-year securities tomorrow.

Yields on Fannie Mae’s current coupon 30-year fix-rate mortgage bond declined to 2.8 percent today, the lowest since Jan. 19, as investors bet the Fed will continue easing. The yield declined to 81 basis points more than 10-year U.S. government debt, near the tightest so-called spread since May.

U.S government securities have lost 0.8 percent in 2012, the most since a 2.2 percent loss in the first few weeks of 2009, according to Bank of America Merrill Lynch indexes. Treasuries fell 3.7 percent in 2009, the only year since 1999 they didn’t post gains.

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